Throughout the history of IMF lending, the institution has had preferred creditor status – that is, distressed countries borrowing from the IMF are expected to give priority to meeting their obligations to the IMF over those to other creditors. This status is a defining characteristic of the IMF’s role in financial crises – it provides a high degree of confidence that IMF resources are safe when other creditors face substantial uncertainty about full repayment.
The case for the IMF’s preferred status is not often questioned. There is something of a mantra within the Fund and among many Fund watchers that the status is appropriate to protect the resources of an institution that is the closest thing to an international lender of last resort. The preferred status permits the IMF to help distressed countries formulate policies necessary for restoring economic stability and a manageable level of debt, and to have credibility-enhancing ‘skin in the game’ while putting its own financial resources at minimal risk. Moreover, the IMF lends at very low interest rates when risk premia are typically very high – the preferred status is, in a sense, compensation. It is argued that without it, the Fund would have to be more cautious to whom it lends and could, therefore, be reluctant to play a full role in the most severe debt crises.
Yet, this case rests on the credibility of the IMF in ensuring that distressed countries to which it lends have made policy changes (including debt restructuring where necessary) that will expeditiously stabilize the economy and catalyse market lending. But in 2010, when the IMF committed €30 billion to Greece – the largest amount ever to a single country – it introduced a permanent option to waive the requirement that borrowing countries be on a path to debt sustainability.
The option of waiving the criterion on debt sustainability while maintaining the creditor status raises several questions.
- By insulating the Fund’s resources from any future debt restructuring, does the preference reduce the Fund’s accountability and introduce moral hazard into lending decisions?
- By facilitating IMF financing of pre-restructuring bail-outs of some private creditors, does the status, in fact, have the opposite effect to the intended catalytic role of the IMF?
- Finally, if the Fund lends with preference when restructurings are ultimately needed, how long will markets desist from challenging the preferred status during mid-program debt restructuring?
In sum, are the traditional arguments for a preferred creditor status still valid after the introduction (and use) of an option for waiving the requirement that IMF programs be highly likely to produce debt sustainability?
The IMF’s preferred creditor status – the facts and the record
The IMF’s preferred status is de facto rather than de jure. The conventional wisdom within the international community is that the creditor status, along with conditionality on the agreed policy program of a borrower, is a critical part of the Fund’s mandate to require ‘adequate safeguards’ on its outstanding credits. However, it is an agreed principle among, rather than a legal requirement on, its members.
The preferred status is not mentioned in the IMF’s Articles of Agreement. Indeed, Martha (1990) argues that the original Articles of Agreement implicitly envisage that at least some private creditors should have precedence over the IMF in a country’s debt servicing. Only in 1988 did PCS receive a formal – though still not legally binding – endorsement from the IMF Board of Governors’ Interim Committee.1 Then, in the context of efforts to address a growing problem with arrears of low-income countries to the IMF, the committee “urged all members within the limits of their laws to treat the Fund as a preferred creditor.”
More recently, the de facto/de jure distinction has attracted attention for its possible relevance to determining whether drawing on IMF resources constitutes a debt restructuring owing to the subordination of existing bondholder claims (Cotterill 2012). The preferred status also affects the provision of resources to the IMF. Member countries have several different arrangements for funding and accounting for their quota subscriptions (or outright loans) to the IMF, but many are heavily influenced by the (perceived) protection that comes from the preference.
Throughout the IMF’s history, the creditor status has worked reasonably well. Rarely has the IMF not been paid on time, and even less frequently has it not been fully repaid. Apart from what is likely to be a genuine commitment to the spirit of the de facto preferred creditor, two specific factors mitigate against reneging on obligations to the IMF:
- First, delayed repayment, let alone default, to the Fund casts countries in pariah status.
- Second, when a country’s return to stability takes longer than initially envisaged and the threat of arrears is acute, the Fund works with the country to put a follow-up lending arrangement in place. In effect, this is evergreening, albeit in the context of a new program to strengthen policy adjustments to ensure that economic stability and the capacity to repay the Fund are restored.
The major weakness in the record of countries repaying the Fund was among low-income borrowers during the 1980s. In the early 1980s, a bulge in lending to low-income countries gave way to a spate of arrears during the late 1980s and early 1990s. Boughton (2001) points to “conventional wisdom” that the arrears problem arose from “the IMF under political pressure…being lax in controlling its lending in the early 1980s.” Addressing these arrears cases brought forth a significant effort to set penalties (ranging from ‘naming and shaming’ to ineligibility to draw on Fund resources to potential expulsion from the Fund) and establish procedures for assisting countries in arrears. The latter involved strengthening adjustment programs, finding official creditors to provide financing to reduce arrears to the Fund, and then providing fresh IMF funding through newly established concessional facilities at the IMF – in effect, restructuring IMF credits.
The Eurozone crisis – a game-changer?
The Eurozone crisis put the role of the IMF’s preferred creditor status in a new light. At least implicitly, tension has always existed between two possible effects of the status:
- On the one hand, facilitating the IMF’s role in supporting corrective policy programs in distressed countries with its own resources; and
- On the other, introducing moral hazard into IMF lending decisions when political pressures to lend are strong.
Historically, the former has dominated, in large part because the IMF has had a reasonably strong framework constraining its discretion. But after that framework was weakened to permit the IMF to lend in the Eurozone crisis, the latter – the preferred creditor as a source of moral hazard – takes on greater weight.
The scope for moral hazard stemming from the creditor status was evident from the beginning of the IMF’s involvement in the Eurozone crisis. Publicly available records indicate that some member countries asked for explicit confirmation of the IMF’s preferred status prior to approving the loan to Greece in May 2010: “The US chair (supported by Brazil and Switzerland) emphasized that, because of the [preferred creditor status], the Fund’s loan will be senior to bilateral loans from EU countries pooled by the European Commission. Staff confirmed that this is the case, because of the public good nature of Fund financing, and in accordance with Paris Club’s rules” (Catan and Talley 2013). The request for confirmation of the Fund’s preferred status revealed concerns that without an up-front debt restructuring, the program of policies would not return Greece to stability.
Preventing loans in such circumstances was precisely the objective of the four criteria for exceptional access adopted in 2002 (see Schadler 2013). The criteria require that:
- The borrowing country experiences “exceptional balance-of-payments pressures”;
- A “rigorous and systematic analysis indicates that there is a high probability that the member’s public debt is sustainable in the medium term”;
- “The member has prospects for gaining or regaining access to private capital markets within the time frame when Fund resources are outstanding”;
- The country’s policy program “provides reasonably strong prospects of success”.
However, in approving the lending arrangement for Greece, the IMF’s Executive Board introduced an option for waiving the second criterion – that requiring a high probability that the program of policies would return public debt to a sustainable level.
The primary concern of Executive Directors requesting clarification of the IMF’s preferred status therefore was that without a reiteration of the commitment to it, the significant probability of a debt restructuring would put the Fund’s resources at an unacceptable risk.
A second concern behind the call for reaffirmation of the IMF’s preferred creditor was the position of IMF credits relative to official European lending to Greece. Indeed, obligations to the European Central Bank (ECB) and national central banks were excl